NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Andrea Buffa

Department of Finance
Boston University
595 Commonwealth Avenue
Boston, MA 02215

E-Mail: EmailAddress: hidden: you can email any NBER-related person as first underscore last at nber dot org
Institutional Affiliation: Boston University

NBER Working Papers and Publications

September 2014Asset Management Contracts and Equilibrium Prices
with Dimitri Vayanos, Paul Woolley: w20480
We derive equilibrium asset prices when fund managers deviate from benchmark indices to exploit noise-trader induced distortions but fund investors constrain these deviations. Because constraints force managers to buy assets that they underweight when these assets appreciate, overvalued assets have high volatility, and the risk-return relationship becomes inverted. Noise traders bias prices upward because constraints make it harder for managers to underweight overvalued assets, which have high volatility, than to overweight undervalued ones. We endogenize the constraints based on investors' uncertainty about managers' skill, and show that asset-pricing implications can be significant even for moderate numbers of unskilled managers.
 
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